Understanding the Capital Stack is Critical in Today’s Market
By Jim Leslie
The underlying debt and equity which capitalize real estate assets has changed dramatically in the past 10 years. With the acceptance and explosion of Commercial Mortgage Backed Securities (CMBS), developers and investors have been able to piece together very aggressive debt structures, reducing the equity requirements of the owner. This structure makes sense and works wonders for financial modeling as long as demand for space remains strong. The typical projections for these types of structures routinely assumed ever increasing rents with no slowdown in leasing velocity. This gave Wall Street underwriters justification for doing more of the CMBS product and justifying debt ratings to lower the cost of the debt. We are all aware of the financial meltdown caused by the realization that these assumptions were faulty, and as a result the “low risk” nature of the CMBS product was recognized to be fool’s gold.
This unsettled debt market creates opportunities as well as obstacles for tenants. Careful analysis and understanding of the “capital stack” is critical for consulting with the tenant as to the correct course of action in renewing their lease or committing to a new building. Owners with CMBS debt have many issues to contend with and few answers. Most have maturities in the near future with no prospects for refinancing at the current debt levels. Others have depleted all of their cash reserves and are not in a position to invest any money into the building for tenant improvements and other transaction costs. In either instance these are issues advisors need to be fully informed about before introducing the tenant to the opportunity.
It is important to spend more time on the initial underwriting of prospective buildings to know how the developer/owner is capitalized in order to structure a transaction that is acceptable to both the landlord and the tenant. That being said there are still traditional capital stacks in many of the buildings throughout the country, but one must inquire early in the process. Our Capital Markets group can help you understand the objectives and limitations a landlord may have based on the financing in place on the building. This knowledge should be very helpful as tenants strategize with their advisors as to the approach to take with each prospective building. All of this chaos can bring opportunities we have never experienced before.
Tags: capital stack, CMBS, commercial mortgage backed securities, debt structures, real estate assets
This entry was posted on Wednesday, February 3rd, 2010 at 5:35 pm and is filed under Capital Markets. You can follow any responses to this entry through the RSS 2.0 feed. Both comments and pings are currently closed.